The Rise of Sovereign Debt Yields

Last week began with a significant risk-on sentiment but ended with equities falling and safe havens rising, as sovereign debt yields increased significantly. Calling to short EURJPY at 132.32 played extremely well but the rest of my calls (short USDCAD, short EURUSD, short GBPUSD) were not triggered.

I do not expect another week of rising sovereign debt yields.

Major last week’s events:

• Oil market: Oil continued rallying. On Wednesday Brent reached $86.60 and WTI $76.78
• Tariffs’ front: A collision between a Chinese and a US war ship was avoided the last minute in South China Sea. The warnings of Mike Pence issued on Thursday regarding the incident triggered a risk off sentiment
• NAFTA: Contrary to my last week’s remarks, that were composed on Saturday, USA and Canada met the Sunday deadline and reached a deal.
• India: One would expect the fast growing India to get closer with USA due to it’s historic rivalry with China. Yet the fact is that India continues buying oil from Iran and finalizes a $5bn purchase of missile defense systems from Russia and negotiates an extra $3bn purchase of Russian helicopters.
• North Macedonia: Participation rate at the referendum was only 35%, and the result was a 91% vote in favor of the name and constitutional changes. History is dictated by people who show up and vote, so I assume that the Greek-North Macedonia deal is still on.
• Cryptos: Total market cap at $220bn $219bn, +0% w/w, -74% from January’s $821bn peak, +17% from the $186bn low.

Major next week’s events:

• Thursday’s release of OPEC’s monthly report and Thursday’s release of US oil inventories
• World Bank and IMF annual meeting starts on Friday.
• Friday’s scheduled hearing of Pastor Brunson in Turkey. Remember that Turkey’s unwillingness to release him, fueled the big TRY summer losses.
• Sunday’s Bavarian Elections

JPY

I am expecting one more week of stronger USDJPY and weaker EURJPY.

I am keeping my short EUR/JPY position, opened at 132.32

Snapshot improved further-Arguments unchanged:

• Core CPI (=BOJ’s compass) at 0.9% (vs 2.0% target and BOJ’s members’ expectation of 1.2~1.3% within 2018), BOJ rate at -0.1%
• GDP at 1.00% annual, 0.7% q/q, 10Y Government bonds yield at 0.16% (+3bps w/w) vs BOJ’s target of 0.00±0.20% level
• Unemployment at 2.4%

Strengths of JPY:

• Abe’s win at the Liberal Party elections provide stability. An expected cabinet’s reshuffle could further boost Japanese equities.
• QQE will stay, up until core CPI reads 2.0% in a stable manner. The scheduled VAT hike in Oct’19, rules out any possible monetary policy change, before 2020.

• improving macro readings: GDP reading, inflation, unemployment, bank lending, retail sales, housing spendign, housing market, capital spending and sentiment readings

Weaknesses of JPY:

• deteriorating macro readings: Manufacturing PMI,Services PMI, monetary base,trade balance and current account

Watch:

• Tuesday’s Current Account and Economic Sentiment, Thursday’s bank lending, Friday’s M2

• Next Monetary Meeting on 31 October

CAD

I am entering short USD/CAD at 1.3014 targeting 1.2690

Snapshot improved further.

• Inflation at 2.8% (vs 2.5% target, BOC expects 2.0% within 1Q19), BOC rate at 1.50% (4 hikes so far, neutral rate according to BOC within 2.5%~3.5% range).
• GDP at 1.9% (vs. BOC expectations of 2.0% in 2018 and long term potential of 1.8%), GDP m/m increased to 0.2%, 10Y Government bonds yield at 2.59(+16bps w/w).
• Unemployment at 5.9%

Strengths of CAD:

• NAFTA. Nafta deal has been eventually reached and the impact on USDCAD was huge.
• next monetary meeting on the 24^th of October may include a rate hike
• at the OPEC+ meeting, no oil production increase agreed. Oil prices are increasing and new highs are expected. Apart from the lower supply due to Iran sanctions, I am expecting a demand shock on January ’19 as marine-time industry would start asking for refined oil to be used at all ships traveling in European ports.

• improving macro readings: GDP, foreign securities purchases

Weakness of CAD:

• OPEC’s monthly report may include a decreasing demand reading

• deteriorating macro readings: unemployment (new release this week, housing market, wholesale sales, and retail sales

Watch:

• Monday is a holiday. No market moving releases are expected

• Next Monetary Meeting on 24 October

AUD

Being long AUDUSD played awfully during the last week. Yet, not being long at current levels would be a bigger mistake.

I am long AUDUSD and expect Australian Household consumption to increase. Latest Retail sales release was a nice indication.

Snapshot unchanged-Arguments unchanged:

• Inflation at 2.1% (expected at 1.75% later in 2018 and then higher in 2019), RBA ‘s rate at 1.50% (no hike so far)
• GDP at 3.4% (RBA expects more than 3.0% within 2018 and 2019), 10y Bond yields at 2.71% (+4bps w/w)
• Unemployment at 5.3% (expected to reach 5.0% by 2020)

Strengths:

• The Australian political drama is over. The 20^th of October snap election for the seat of the former PM, is not expected to result into a new government.
• improving macro readings: GDP, employment change, household consumption recovered in 3Q18, retail sales, trade balance

Weaknesses:

• market participants expect the RBA’s rate to remain unchanged and not follow the rate hike schedule of other Central Banks
• deteriorating macro readings: current account,company operating profits, decreasing capital expenditure, building approvals, home sales, confidence and consumer sentiment

Watch:

• Wednesday’s Consumer Sentiment and Thursday’s Inflation expectations

• Next Monetary Policy meeting on November 5

 

USD

USD had an impressive week, following the increase of sovereign bond yields.

I would exit long USD positions at current levels, expecting a corrective move from previous week.

Snapshot improved:

• Core PCE (=FED’s inflation compass) at 2.0%, CPI at 2.7%, FED ‘s rate increased to 2.25% (IOER) and expected to reach 3.1% within the cycle. FED’s view of long run rate at 2.9%
• GDP at 2.9%y/y, 4.2% q/q, 10y Bond yields at 3.20% (+14 bps w/w)
• Unemployment decreased to 3.7% (vs natural rate of unemployment of 4.5%), FED expects 3.6% unemployment in 4Q18 and 3.5% for 2019 and 2020.

Points to be considered

• inflation is not worrying. Latest releases showed decreasing numbers, latest core PCE index decreased to 0.0% m/m, labor cost data decreased & Trump canceled a 2.1% wage raise for federal employees

• business inventories rising and retail sales falling are signaling a downtrend.

• three new narratives capable of boosting US markets for another semester are in the making (a) indexing inflation so that long term capital gains are taxed lower (b) publishing earnings every 6 months instead of every 3 months can bring creative accounting. (c) 3Q earnings are once again expected higher than 20%

• GDP, Manufacturing PMI, Non-manufacturing PMI, durable goods orders are all recording big numbers.

• risk-on news like a EU-UK negotiations concluding, consensus with China, may simultaneously hit the headlines sending USD lower. Nafta deal actually happened but it only affected USDCAD

Watch:

• Wednesday’s Wholesale inventories

• Thursday’s inflation readings

• Friday’s Consumer Sentiment and Inflation expectations

• Next Monetary meeting on November 8, following the Midterm Elections.

 

EUR

I keep my short EUR/USD bias for another week. 1.1597 and 1.1637 are nice entry levels.

Snapshot mixed:

• Annual CPI at 2.1%, core CPI (=ECB’s compass) at 0.9%, ECB ‘s rate at 0.00%
• GDP at 2.1% growth (OPEC reduced expectations to 2.0%), 10y Bond yields of EFSF at -0.32% (+3bps w/w), 10y German Bond yields at 0.56% (+9bps w/w), 10y Italian Bond yield at 3.41% (+27bps w/w, +57bps in 2 weeks), 10y Greek Bonds yields at 4.51% (+33bps w/w, at the sixth week following bailout protection)
• Unemployment decreased to 8.1%

Strengths of EUR/USD:

• Given that the announced Italian budget was 2.4% deficit for 2019 with the intention to decrease it later, I believe that Italian political risk needs to be priced lower. Markets are overreacting at the moment.

• excluding Italy, fiscal policies will not be as neutral as previously expected.

• improving macro readings: risk-on sentiment, improvement of labor market and wage growth, private loans, decreasing unemployment,increased German factory orders

Weaknesses of EUR/USD:

• Bavarian elections on Sunday

• bond yields of European periphery further increased. On October 26 S&P credit agency will rate Italian debt and there is a chance of a downgrade

• the different stages of monetary policy between EU and US, can only be simulated with another dip of EUR/USD in mid December. (the expected dip on late September has already happened)

• deteriorating macro readings: current account, M3, retail sales, trade balance, investor confidence

Watch:

• Monday’s Investor Confidence

• Next Monetary Meeting on 25 October.

GBP

I would avoid offering a view on GBP as we are approaching the 17^th of October EU summit and the Novembers extra summit, even while EU and UK acknowledge that they would be better off with a deal in place. The timing of the protagonists remarks, as they break the headlines and cause big market moves, cannot be anticipated and traded.

Snapshot and Arguments unchanged:

• Inflation at 2.7% (vs 2.0% target), BOE ‘s rate at 0.75%
• GDP at 1.2% growth (vs 1.75% BOE’s expectations and 1.3% decreased OPEC’s expectations), 10y Bond yields at 1.69% (+12bps w/w)
• Unemployment at 4.0%

Strengths:

• positive macro releases: Services PMI and Manufacturing PMI, consumer’s inflation expectations increased

Weaknesses:

• inflation is peaking up again while BOE has only signaled 3 hikes for the next 3 years. It will be a very hard task to fight inflation and GBP weakening at the same time
• a no deal with EU is possible. In this case UK would be able to be competitive to EU regulatory wise, but would loose tax revenues from the decrease of financial activity in the City.
• the no deal scenario has already been characterized as bad outcome by Mark Corney (Governor of BOE) and has been quantified to be equal to a £80bn in public finance by Philip Hammond (Head of Treasury)

• Negative macro releases: consumer’s confidence, current account, average earnings, industrial order expectations,

Watch:

• UK politics and negotiation process.

• Wednesday’s GDP reading, Manufacturing Production and Construction output. None is expected to record improving numbers

• Next Monetary Meeting on 1^st of November.

 

Disclaimer

Issued by Labis Michalopoulos, CFA

labis@email.com

https://quantomental.com

https://dxml.wordpress.com

Readers checking the returns at www.forexfactory.com/dxmix will notice a leveraged trade on AUDUSD opened on 24 August that ruined the hard earned statistics of 0.5 montly Sharpe Ratio, for over 45 months. I mistakenly ordered to open a position 10 times bigger than I am used to, and my reaction to the mistake was a series of new wrong actions.

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